Friday, October 19, 2007

M-LEC, the new entity created by the nation's largest banks to provide liquidity to subprime-linked securities is off to a rough start. Many criticisms have been made, ranging from charges of possible self-dealing by banks to questions on who exactly will provide the funds. But even if you set those concerns aside, there's another issue that Alan Greenspan points out in an interview with Emerging Markets:

In the case of LTCM, “a single company” that was “excised out of the market”, there had been a potential for “a dangerous firesale of those assets”. When shareholders came in and took out LTCM, that “eliminated that aspect of market disruption”.

In contrast, “here we’re dealing with a much larger market,” he said. “They’re not talking about going in and absorbing sub-prime mortgage asset backed [securities]. They’re talking about essentially increasing the liquidity of those who have the SIVs [structured investment vehicles] and the like.”

JP Morgan Chase chief executive Jamie Dimon said on Wednesday that the fund – which will buy securities most notably ABS (asset backed securities) – could relieve some market pressure caused by the problems of SIVs. The plan is designed to prevent SIVs being forced to dump assets in a weak market because nervous investors are refusing to buy their new commercial paper.

But Greenspan argued that that a delicate market psychology could be speared by the move. “It could conceivably make [conditions affecting investor psychology] somewhat adverse because if you believe some form of artificial non-market force is propping up the market you don’t believe the market price has exhausted itself.

“What creates strong markets is a belief in the investment community that everybody has been scared out of the market, pressed prices too low and they’re wildly attractive bargaining prices there,” he said.

“If you intervene in the system, the vultures stay away,” he said. “The vultures sometimes are very useful.”

In other words, trying to inflate a punctured balloon is useless.

By the way, Yves Smith over at Naked Capitalism has covered this issue better than anyone. Do pay him a visit.